Why in news?
Rupee has appreciated around 6.1% against the dollar so far in 2017.
What are the shortcomings?
- It can cause damage in term of lost exports growth.
- There might also be a fall in domestic production due to cheapening imports.
- In the current year so far, a total of $31 billion of FPI flows have already come versus an outflow of $2.7 billion in the same period.
- This is because interest rates are significantly higher in India.
- So around 2/3rdof the FPI flows have been in the form of debt instruments like bonds and securities.
- This rate is not slowing down in the near future as the US economy is not reflating at the expected pace.
- In this case, FPIs benefit from both the higher interest rates as well as the appreciation of the rupee.
- More the inflows, greater will be the appreciation.
- This would make India a suitable place for carry trade.
- A carry trade is a strategy in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return.
- It makes our exchange rate more volatile and also drains our forex.
What has RBI done to tackle this?
- RBI has purchased $20 billion, half each in the spot and forward markets.
- RBI has tried to slow debt inflows by tightening norms for masala bonds.
- The tenors were raised to 3-5 years and an interest rate cap was imposed.
- RBI also said that each issue would be cleared by it.
- SEBI reinforced this with a temporary ban on new issues.
- RBI also tried to increase the maturity profile of FPI investments in G-Securities.
What should be done?
- There is no short-term solution to slowing, or reversing the rupee’s appreciation.
- There should be sharper cuts in interest rates.
- Inflows should be slowed down by promoting outward FDI.
- The automatic hikes that were put in place for FPI positions in the bond market two years ago should be relooked to make it serve as a cap to debt inflows and the rupee’s appreciation.
- Government has to create enough fiscal space to be able to service the resulting lower interest rates.
- RBI has been using stronger rupee as an inflation-fighting tool.
- It is time for RBI to shift the focus and estimate the damage caused by an appreciating rupee and to take necessary steps.
Source: The Financial Express
